Ad-hockery follow up

One issue that was raised in our discussion of CEO pay was whether CEO pay practices were responsible for the financial meltdown. Roy C. Smith, professor of finance at NYU, lists this idea as the first of five myths about executive pay to be debunked:

1. The Wall Street bonus culture led to the financial crisis.

There is absolutely no evidence to support this. The crisis was caused by a combination of lax monetary policy, loose regulation across the entire financial sector, yield-chasing by institutional investors craving decent returns in a weak market and a vast global banking industry that turbocharged the whole process. The bonus system, which has always been part of the securities industry’s DNA, may have encouraged risk-taking by major banks, but it also encouraged risk management and other disciplined forms of corporate governance that are supposed to accompany the incentives. In a number of cases, however, these risk-management systems were totally inadequate in the face of the market tsunami that enveloped mortgage-backed securities after home prices began to drop in 2006. The storm carried away several firms, but others performed well despite the difficulties. It wasn’t the bonuses that brought everything down; it was a combination of many things, some sloppy or foolish, and most far more important than bonus checks.

Another issue that was raised was whether the government has a role in regulating business, including setting rules for executive pay. Although there is evidence to show that much business regulation is counterproductive because of regulatory capture and the inability of government regulators to respond to quickly changing conditions, I do believe the government has role in setting rules for the market place.

Rule-setting is one thing. The routine involvement of individual politicians in business operating decisions is something else entirely:

Since the financial crisis broke, Congress has been acting like the board of USA Inc., invoking the infusion of taxpayer money to get banks to modify loans to constituents and to give more help to those in danger of foreclosure. Members have berated CEOs for their business practices and pushed for caps on executive pay. They have also pushed GM and Chrysler to reverse core decisions designed to cut costs, such as closing facilities and shuttering dealerships.

You wanna make some rules? Fine, make some rules. But I don’t think that micromanagement of businesses from Washington holds is the best way to encourage economic recovery.



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